Stock Analysis

Sprouts Farmers Market (NASDAQ:SFM) Seems To Use Debt Quite Sensibly

NasdaqGS:SFM
Source: Shutterstock

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Sprouts Farmers Market, Inc. (NASDAQ:SFM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sprouts Farmers Market

What Is Sprouts Farmers Market's Net Debt?

As you can see below, Sprouts Farmers Market had US$250.0m of debt, at October 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$316.7m in cash, so it actually has US$66.7m net cash.

debt-equity-history-analysis
NasdaqGS:SFM Debt to Equity History February 6th 2023

A Look At Sprouts Farmers Market's Liabilities

The latest balance sheet data shows that Sprouts Farmers Market had liabilities of US$525.1m due within a year, and liabilities of US$1.45b falling due after that. On the other hand, it had cash of US$316.7m and US$11.5m worth of receivables due within a year. So its liabilities total US$1.65b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sprouts Farmers Market is worth US$3.46b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Sprouts Farmers Market boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Sprouts Farmers Market saw its EBIT drop by 6.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sprouts Farmers Market can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sprouts Farmers Market may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Sprouts Farmers Market produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Sprouts Farmers Market's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$66.7m. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in US$262m. So we don't have any problem with Sprouts Farmers Market's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Sprouts Farmers Market .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Valuation is complex, but we're helping make it simple.

Find out whether Sprouts Farmers Market is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.